One (REIT) Ring To Rule Them All

by: Kevin Quon

With the pursuit for dividend income on the rise, many investors looking for higher yields eventually turn to real estate investment trusts (REITs) as a means to accomplish this goal. With a special designation that reduces and often eliminates taxes on the corporate level, REITs are entities that were intended to create a similar investment structure to that of a real estate mutual fund. In order to maintain their designations REITs are required to distribute 90% of their taxable income into the hands of investors. Such a requirement often results in the higher income yields typically associated with REITs. For investors, REITs offer enhanced income opportunities. For private management firms, the popularity of REITs can also offer enhanced opportunities for increasing management fees through the growth of assets under management.

Reit Management & Research LLC (RMR) is a large private real estate management company which was founded in 1986 in order to manage public real estate investments often found in the form of REITs. The Massachusetts-based company now serves as the active management firm for CommonWealth REIT (NYSE:CWH), Senior Housing Properties Trust (NYSE:SNH), Government Properties Income Trust (NYSE:GOV), and Hospitality Properties Trust (NYSE:HPT). RMR also provides management services to Five Star Quality Care Inc. (NYSE:FVE), a tenant of SNH, and to TravelCenters of America LLC (NYSEMKT:TA), a tenant of HPT.

Through RMR's affiliate, RMR Advisors, Inc also serves as the manager of publicly-offered mutual funds. Closed end funds RMR Real Estate Income Fund (NYSEMKT:RIF) and RMR Asia Pacific Real Estate Fund (NYSEMKT:RAP) both trade on the NYSE Amex under the management of RMR Advisors. Altogether, as of September 30, 2011, RMR and its affiliates had total gross assets of nearly $20 billion under management, including a diversified portfolio of over 1450 properties located throughout the United States, Canada, Puerto Rico, and Australia.

As a result of this arrangement, there are several consequences that investors should be aware of:

  • Close arrangements exist between many of the previously mentioned REITs.
  • None of the aforementioned REITs have any full time employees.
  • RMR operates under lower corporate expenses than comparable REITs thereby offering a competitive advantage for the companies under management.
  • The corporate goals of RMR might take precedence over shareholder interests in each individual REITs.

Perhaps perceived to be both a pro and a con, the implied management of RMR creates an overarching investment structure of which investors often fail to realize in its entirety. In the instance of SNH & GOV, both served as spin-off IPO's off of HRPT properties trust, the predecessor to CWH. Though each were formerly 100% owned subsidiaries, RMR spun off these entities dissolving much of the parent company's original property diversification. By narrowing the focus of parent REIT, RMR also increased its assets under management often at the expense of the original entity. In the case of GOV, CWH now retains a meager 21.1% of GOV's outstanding common shares in its enlarged public state.

The same strategy appears to be in the works again for RMR. Once again, working through its managed company of CommonWealth (CWH), RMR recently created another subsidiary dedicated to investing primarily in net-leased, single-tenant properties under the name of Select Income REIT (NYSE:SIR). On December 22, CWH announced the intended spin-off of Select Income REIT in an planned IPO expected to raise $230 million.

The following day Standard & Poor's (S&P) placed CWH on CreditWatch, citing the IPO of SIR had the potential to negatively affect CWH's creditworthiness. Quoting analyst Susan Madision in the announcement, she states: "CommonWealth intends to contribute 253 properties to the subsidiary, and these properties include some of the CommonWealth's most stable assets." Indeed, attesting to these negative implications, the rating agency continued to express anxiety by giving the company a 'BBB' corporate credit rating that adversely affects CommonWealth's outstanding $3.5 billion in obligations.

For investors in CWH, the move could easily be deemed unnecessary and exposing, at least in the current environment. And yet, the spin-off does provide one silver lining opportunistic benefit that can partly justify the RMR's IPO strategy. Through the establishment of the separate public entity, CWH is able to disinvest the subsidiary's portfolio quicker and at will than it otherwise could have. In doing so, SIR in part becomes a possible liquidity generator for CWH's investors.

In the end, RMR's interests can clearly be seen in the methodology of its own management expansion. However, this is not to suggest merely a negative perspective. As it stands, the companies under RMR's management currently tend to support very lucrative returns for investors with above average dividend yields. Yet investors should be aware of these implications of RMR's management, for better or worse, and make their investment decisions on the basis of their own individual needs.

Disclosure: I am long CWH.

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